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Judgments - Smith (FC) (Appellant) v. Secretary of State for Work and Pensions and another (Respondents)

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    19.  There is no doubt that, as this case shows, the approach in para 2A can produce unsatisfactory results. The fact that Mr Smith voluntarily paid a much larger sum does not alter that fact. Counsel for the Secretary of State tried to argue that, where the figure produced by using para 2A was inappropriately low, the matter could be put right by a departure direction in terms of regulations 25 and 40(5). But such a direction can be made only when the Secretary of State is satisfied that the current assessment is based on a level of income which is substantially lower than the level of income required to support the overall lifestyle of the non-resident parent. Therefore, if the non-resident parent chooses to live modestly, regulation 25 is not engaged. The regulation is directed at an entirely different problem and is not designed to deal with the difficulties thrown up by the application of regulation 2A in a case like the present where the non-resident parent quite properly deducts large capital allowances in submitting his figure for total taxable profits in his tax form. So, if the interpretation of para 2A(2) were doubtful, the departure direction regulations would not be a factor in favour of the construction which I prefer.

    20.  Counsel for the appellant contended that, as interpreted by the Secretary of State, para 2A was incompatible with article 8 of the Human Rights Convention. Purely for the purposes of the present case, counsel for the Secretary of State was prepared to concede that article 8 was engaged. Even so, I am satisfied that there is no breach of the article. Para 2A does not involve any positive encroachment on the appellant's family. But her counsel argued that it failed to respect the family life of the appellant and her children because it did not support it by ensuring that they received regular support at an appropriate level. The failure of the system, at one stage, to provide that the respondent should pay an appropriate figure by way of support to his children is indeed all too clear. None the less, when that happened, the appellant was entitled to income support. So there is nothing to show that the relationships and contacts between the appellant and her children were actually adversely affected by lack of adequate support from the respondent. In these circumstances the appellant has not established that the operation of para 2A resulted in a violation of her article 8 rights.

    21.  For these reasons, as well as for those given by my noble and learned friend, Lord Nicholls of Birkenhead, I would dismiss the appeal. It would give me no particular satisfaction to do so, since the state of the regulations is obviously far from satisfactory. His counsel assured the committee that the Secretary of State was well aware of the problem. It is therefore to be hoped that, in the course of the current review of the child support system, appropriate changes will be made as a matter of urgency.


My Lords,


    22.  The Child Support Act 1991 ("CSA 1991") has been the subject of public concern and political controversy since its inception. One reason (although by no means the only reason) for this is the complexity both of CSA 1991 itself and of the secondary legislation by which it is given effect. The statutory instruments of particular relevance to this appeal are the Child Support (Maintenance Assessments and Special Cases) Regulations 1992 (SI 1992/1815) ("MASC") and the Child Support Departure Direction and Consequential Amendments Regulations 1996 (SI 1996/2907) ("DDCA"). CSA 1991, MASC and DDCA have all been substantially amended. There have also been substantial changes, since the enactment of CSA 1991, in income tax law, and in particular in income tax law as it applies to individuals carrying on business as sole traders.

    23.  This appeal is concerned with the liability of a sole trader, Mr Robert Smith, to pay child support for the benefit of his three children. He is (in the old terminology) their absent parent ("AP") or (in the new terminology) their non-resident parent. A special feature of his trade was that it generated substantial capital allowances for income tax purposes. The determination of Mr Smith's liability under CSA 1991, in changing personal circumstances and under changing legislative conditions, has been a protracted and deeply unsatisfactory saga. But for the purposes of this appeal your Lordships are principally concerned with the facts as they stood, and the law as it stood, in September 2001. That is because (although other aspects of the decision are very much in issue) no one has challenged the finding by the Child Support Appeal Tribunal:

    "The relevant week is 17-24 September 2001, and accordingly the accounts for the year ended 31 March 2001 together with the tax return for the tax year ending 5 April 2001 are the relevant documents for the purposes of calculating the respondent's income."

    24.  Because of the complexities it may be helpful to note at the outset, in chronological sequence, some salient points as to the development of child support law and tax law between 1990 and 2001. Many of the points noted here will have to be revisited and examined more closely.

    (1)  The system of capital allowances for income tax and corporation tax purposes (first introduced in a recognisably modern form for income tax in 1945, and frequently changed, especially in the 1980s) was consolidated in the Capital Allowances Act 1990 ("CAA 1990").

    (2)  CSA 1991 was foreshadowed in the White Paper, Children Come First, vol 1 (Cm 1264) published in 1990. The White Paper set out its aim (para 2.1) as a system of child maintenance which would (among other things):

    " -  produce consistent and predictable results so that people in similar financial circumstances will pay similar amounts of maintenance, and so that people will know in advance what their maintenance obligations are going to be;

    -  enable maintenance to be decided in a fair and reasonable way which reduces the scope for its becoming a contest between the parents to the detriment of the interests of the children.

    -  produce maintenance payments which are realistically related to the costs of caring for a child."

(3)  The general scheme and structure of CSA 1991 have recently been considered by this House in R (Kehoe) v Secretary of State for Work and Pensions [2006] 1 AC 42 (see especially the speech of Lord Bingham of Cornhill at p 55, para 4). For present purposes the most important provisions of the statute in its original form were section 11(2) and Schedule 1. Section 11(2) provides:

    "The amount of child support maintenance to be fixed by any maintenance assessment shall be determined in accordance with the provisions of Part I of Schedule 1."

    Schedule 1 cannot be summarised concisely and I shall come back to it.

    (4)  The mid-1990s saw major changes in the taxation of business profits made by an individual (a company's business profits were taxed on the current year basis from the inception of corporation tax in 1965). The changes have been summarised by Professor Tiley, Revenue Law, 4th ed (2000), p 343,

    "For many years, and for most of the years over which the case-law relevant to Schedule D, Cases I and II has been developed, the profits of a trade or profession were taxed on a 'preceding year' basis . . . After a transitional year in 1996-97 the new 'current year' basis was applied to all such profits as from 1997-98; the new rules were already in force for trades and professions begun on or after 6 April 1994. The same years also saw the start of the new self-assessment regime. Introducing both changes at the same time attracted much criticism."

    Self-assessment for income tax was introduced by the Finance Act 1994 with effect from 1996-1997. In theory it applies to all individual taxpayers, whether traders or not, but in practice self-assessment forms are sent only to the self-employed and other individuals whose tax affairs are regarded as complex.

    (5)  CSA 1991 was significantly amended (in line with the White Paper, Improving Child Support (Cm 2745), published in January 1995) by the Child Support Act 1995 ("CSA 1995"). In particular, new sections 28A to 28I and Schedules 4A and 4B introduced powers enabling a "departure direction" to be made, on the application of either the parent with care ("PWC") or the AP to vary the amount of a maintenance assessment. Section 28F (1) provided:

    "The Secretary of State may give a departure direction if—

    (a)  he is satisfied that the case is one which falls within one or more of the cases set out in Part I of Schedule 4B or in regulations made under that Part; and

    (b)  it is his opinion that, in all the circumstances of the case, it would be just and equitable to give a departure direction."

    This introduced an element of official discretion (which it had been the government's avowed purpose to eliminate by CSA 1991). The weight to be attached to the existence of departure directions (as a means of overcoming apparent inequity in the operation of the statutory formulae) is an important subsidiary issue in this appeal.

    (6)  The Social Security Act 1998 made important changes to the appeal system (sections 40 to 44 being concerned with child support). It is unnecessary to go into the detail of the changes.

    (7)  In 1999 changes were made, by the Child Support (Miscellaneous Amendments) Regulations 1999 (SI 1999/977) to Schedule 1, Part I of MASC, which provides for the calculation of N ("the amount of [the AP's] net income, calculated or estimated in accordance with regulations"—CSA 1991, Schedule 1, para 5(1))—and of M ("the amount of [the PWC's] net income, calculated or estimated in accordance with regulations"—para 5(2)). The effect of these changes is the central issue in this appeal.

    (8)  Another change made in 1999, by the Welfare Reform and Pensions Act 1999, was the amendment of Schedule 2 to CSA 1991 so as to widen the powers of the Child Support Agency ("the CSA") to obtain information from the Inland Revenue. Previously it could inquire only about an AP's address or employer. Under the new para 1A it could seek information as to the earnings or other income of a self-employed AP.

    25.  That is, in barest outline, the background to the issues which your Lordships have to determine. Since the time relevant to this appeal (September 2001) there have been further important changes in the child support system, and counsel for the Secretary of State informed your Lordships that a further review is now in progress. The most important changes so far have been made by the Child Support, Pensions and Social Security Act 2000 ("CSPSA 2000"). It took effect from 3 March 2003 for cases occurring after that date, but has not been brought into force (and may never be brought into force) for cases pending at that date. It would add further unnecessary complication to describe the extensive changes made by CSPSA 2000. The law as to capital allowances has again been consolidated by the Capital Allowances Act 2001.

The facts

    26.  The facts of this case do, as I have said, amount to a most unsatisfactory saga. They are, understandably, set out in all their unhappy detail in the appellant's printed case. But for the determination of this appeal it is sufficient to give a short summary, taken largely from the agreed statement of facts and issues.

    27.  Mrs Helen Smith, the appellant, and Mr Smith, the first respondent, separated in December 1997 (and have since been divorced). They had three children, aged 17, 15 and 14 at the time when the statement of facts and issues was agreed. At all times since December 1997 Mrs Smith has been the PWC and Mr Smith the AP.

    28.  At the material time Mr Smith carried on business as an individual sole trader in the car-hire business. He specialised in adapting cars for use by driving schools and renting them to driving schools for lengthy periods (the appeal tribunal put it as "months rather than weeks"). He had a successful and expanding business. The profits of his trade were taxed under Schedule D, Case I and he was able to claim (and did claim) substantial allowances under CAA 1990. In the period from 1 April 2000 to 31 March 2001 (covered by his self-assessment tax return for 2000-2001 which he signed on 17 December 2001) he made a taxable profit (before capital allowances) of £169,520, reduced by capital allowances of £148, 628 to the sum of £20,892 on which he was charged to tax under Schedule D, Case I.

    29.  Mrs Smith applied promptly for a maintenance assessment (as she was obliged to do, under section 6 of CSA 1991, since after her husband's departure she had to apply for, and was receiving, income support). On 27 September 2001 the CSA made a maintenance assessment of £11.28 per week (for all three children). This was based on Mr Smith's tax return for 1999-2000, in which he also had a claim for substantial capital allowances. Mrs Smith appealed to an appeal tribunal and by the time her appeal was heard Mr Smith's tax return for 2000-2001 was available. On 8 April 2002 the tribunal made a new determination based on a figure of £20,892 for Mr Smith's taxable income (although with an upwards adjustment which, as is now common ground, was erroneous).

    30.  Mrs Smith had also applied for a departure direction under section 28A of CSA 1991 (as amended) and regulations 24 and 25 of DDCA. The Secretary of State referred this application to the tribunal. It declined to make a departure direction.

    31.  Mrs Smith appealed to the Child Support Commissioner and her appeal was heard by Mr Commissioner Howell QC. In his written decision dated 6 October 2003 he defined the issue of law which he had to determine (para 8):

    "In calculating a self-employed trader's earnings for child support purposes, is he or is he not entitled to any deduction for capital depreciation or capital allowances?"

    He resolved this issue in favour of Mrs Smith and allowed her appeal. He did not therefore consider the departure direction issue except to note (para 30) one "plain misdirection" on the part of the appeal tribunal.

    32.  The Commissioner refused leave to appeal, as did Wall LJ on paper. But permission to appeal was granted on a renewed application to the Court of Appeal. On 19 October 2004 the Court of Appeal (Ward and Wall LJJ and Sir Martin Nourse) unanimously allowed Mr Smith's appeal (which was supported by the Secretary of State for Work and Pensions, the second respondent to the appeal). The decision is reported at [2005] 1 FLR 606.

    33.  The Court of Appeal refused leave to appeal to this House. Your Lordships granted leave on 25 January 2005 and expressed the hope that Mrs Smith would be granted legal aid. She now has legal aid (previously she was represented pro bono by the counsel and solicitors now acting for her). The Court of Appeal remitted the matter to the appeal tribunal to determine the amount of the maintenance assessment in accordance with its judgment, and to adjudicate on Mrs Smith's application for a departure direction in accordance with the Commissioner's ruling. The Court of Appeal directed that there should be expedition. Lamentably, however, the appeal tribunal decided on 1 February 2005 to stay the proceedings before it, because of the pending appeal to your Lordships' House. That decision was maintained at a further hearing on 19 April 2005, although both Mr Smith and the Secretary of State were willing for the stay to be lifted. Before your Lordships counsel for the Secretary of State (while disclaiming her client's responsibility for the delay) did not seek to defend the state of affairs during which Mrs Smith has been, for years rather than months, without any valid maintenance assessment in force. Your Lordships were told by Mr Smith's solicitor advocate, on instructions, that Mr Smith has since 2005 been paying £750 a month (as I understand what he said, with reasonable but not total regularity) towards his children's maintenance.

CSA 1991 Schedule 1

    34.  CSA 1991 Schedule 1, in its original form, contained a large number of algebraic formulae. The evident purpose of the formulae was to produce certainty, even at the cost of considerable complexity, in the calculation of the amount of a maintenance assessment. I have already referred to the appearance in Schedule 1, paragraph 5 of the symbols N and M, representing the net incomes of AP and PWC respectively, to be calculated or established in accordance with regulations (that is, MASC—in this case, as amended in 1999).

    35.  No useful purpose would be served by a detailed survey of all the (now obsolescent) formulae in the original Schedule 1. They can be understood only by reference to MASC as from time to time amended. The general scheme is to quantify the basic maintenance requirement (MR) for the child or children in question (Schedule 1, paragraph 1 and MASC regulations 3 and 4). The AP's basic liability is then quantified by reference to his and the PWC's respective assessable incomes (A and C) (Schedule 1, paragraph 2 and MASC regulation 5). The basic liability may be adjusted upwards where the AP is relatively well off (Schedule 1, paragraphs 3 and 4 and MASC regulation 6). However the AP is accorded a measure of protection in that his assessable income (A) is arrived at by the formula A=N - E, N being net income and E being exempt income (Schedule 1, paragraph 5 and MASC regulation 9). Moreover the AP may also have "protected income" (Schedule 1, paragraph 6 and MASC regulations 11 and 12) since (as it was put in the 1990 White Paper, para 3.23):

    "There is no point in alleviating one family's possible dependence on income support at the expense of creating such dependence for another family. The protected level of income will prevent that circumstance arising."

    It is unnecessary, for present purposes, to go further into the complexities of exempt income and protected income. But it is necessary to look closely at the quantification of the AP's net income (N). That is of central importance to this appeal.

The quantification of N: Schedule 1 to MASC in its original form

    36.  In this part of my opinion references to Schedule 1 are not to Schedule 1 to CSA 1991, but to the original Schedule 1 to MASC, headed "Calculation of N and M." Schedule 1, paras 1 and 2 define "earnings" in relation to an employed earner. Para 1 describes (in minute detail) the type of earnings to be taken into account, and para 2 prescribes how they are to be quantified as a weekly figure. Paras 3 and 5 perform the same respective functions in relation to the earnings of a self-employed earner.

    37.  It is noteworthy that para 3 refers to income tax only as a permissible deduction in arriving at the appropriate earnings figure (para 3(3) (c) and (5)). The draftsman has not followed the technique of referential incorporation of provisions of the Income and Corporation Taxes Act 1988 ("ICTA 1988") in defining the concept (familiar for tax purposes) of trading profit. Instead the draftsman has provided his own set of rules, which reproduce more or less faithfully some (but not all) of the familiar tax rules. Thus the permissible deductions under para 3(3)(a) reproduce (but with the introduction of the word "reasonable") section 74(1)(a) of ICTA 1988 and (as extended by para 3(4)(a)) the provision about repairs in section 74 (1)(d) and the exception for interest in section 74(1)(f). The impermissible deductions under para 3(4)(b)(i) to (iii) (that is (i) repayment of capital on most loans (ii) capital expenditure and (iii) depreciation of capital assets) reproduce (in different words) section 74(1)(f) and (g); para 3(4)(b)(iv) (setting up or expansion of business) reproduces other parts of section 74(1)(d) and (f); and para 3(4)(b)(vi) (business entertainment) reproduces section 577 of ICTA 1988. The rules about losses in para 3(4)(b)(v) and (vii) are quite different from those of loss relief under ICTA 1988 Part X, Chapter I (Loss Relief: Income Tax).

    38.  Schedule 1, para 3 says nothing at all about capital allowances as such. But the respondents accept that in view of para 3(4)(b)(i) to (iii) they could not possibly qualify as a deduction under para 3, since they are essentially adjustments made to taxable profits on account of capital expenditure on assets which, over a period, lose their value through wear and tear or obsolescence. Under Schedule 1 in its original form the draftsman in effect wrote out his own Schedule D income tax code, but with two major variations: no capital allowances and no loss relief. Both variations are readily explicable in the context of a system of child support which aims to make an AP's obligations to his children the first charge on his spendable income.

    39.  Schedule 1, para 5 contains provisions for quantifying a person's self-employed earnings (typically recorded in annual trading accounts, or occasionally accounts for a period of more or less than a year) as a weekly amount. In particular para 5(3) permitted a child support officer to use a different period if otherwise the calculations would "not accurately reflect the normal amount of the earnings of the person in question."

The amendment of Schedule 1 to MASC

    40.  In 1994 the House of Commons Select Committee on Social Security made a report The Operation of the Child Support Act: Proposals for Change (Session 1993-94, 5th Report) which was critical of many aspects of the work of the CSA under CSA 1991. The Government responded in January 1995, first with a brief reply (Cm 2743) and then the White Paper Improving Child Support (Cm 2745). Both the reply and the White Paper acknowledged the defects in the system. Numerous changes were proposed, including the introduction of departure directions and a 30% cap on the amount of maintenance which an AP could be required to pay out of his normal net income. In para 24 of the reply it was stated:

    "The Government accepts that the assessment of the self-employed can be administratively complex and agrees to consider ways in which the process could be simplified. It is considering further the best way to deal with these cases."

    41.  In Chapter 6 of the White Paper (Administrative Changes) this was expanded:

    "6.21  The Agency has experienced considerable difficulties in completing assessments where the absent parent is self-employed. These difficulties have often been due to the unavailability of accounts. The Government intends to introduce a further interim maintenance assessment to enable self-employed cases to be assessed quickly . . .

    6.22  In addition, changes will also be made so that accounts over a longer period can be used for estimating earnings, and consideration given to making better use of accounts and information which may already have been prepared for tax and national insurance purposes."

    42.  The introduction of departure directions and other changes in the primary legislation proposed by the White Paper were effected by CSA 1995. The changes in the computation of self-employed earnings, referred to in paragraph 6.22 of the White Paper as under consideration, were effected by the Child Support (Miscellaneous Amendments) Regulations 1999 (SI 1999/977). In introducing the regulations the Government spokeswoman, Baroness Hollis of Heigham, said (Hansard (HL Debates) vol 598, 23 March 1999, col 1269):

    "This package of regulations marks a step along the way of improving the CSA. We all know the difficulty that the CSA has is particularly marked in obtaining maintenance from self-employed non-resident parents. Regulation 6 introduces provisions which self-employed parents should find helpful, enabling them to provide the figures which they use for self-assessment of their earnings for tax purposes, for use in calculating maintenance. Only where they are unable to provide them, for example, if the business is a new one, will the agency have to continue to use the old cumbersome arrangements."

    In short, the change was presented as an administrative improvement, not as a change of substance.

    43.  Regulation 6 amended Schedule 1 to MASC by introducing a new para 2A (backed up by para 2B and para 2C) and a new para 5A. The new para 2A was intended to be the primary means of determining self-employed earnings for the future, but under para 2C the original para 3 remained the default provision applicable when neither para 2A nor para 2B provides the answer.

    44.  The crucial provision of the new para 2A is sub-paragraph (2):

    "'Earnings' means the total taxable profits from self-employment of that earner as submitted to the Inland Revenue, less the following amounts—

    (a)  [income tax on the taxable profits]

    (b)  [national insurance contributions]

    (c)  [half of any retirement annuity premiums]"

    The new paragraphs 2B and 2C provide as follows:

    "2B (1) Where—

    (a)  a self-employed earner cannot provide the child support officer with the total taxable profit figure from self-employment for the period concerned as   submitted to the Inland Revenue, but can provide a copy of his tax calculation notice; or

    (b)  the child support officer becomes aware that the total taxable profit figure from the self-employment submitted by the self-employed earner has been revised by the Inland Revenue,

    the earnings of that earner shall be calculated by reference to the income from employment as a self-employed earner as set out in the tax calculation notice issued in relation to his case, and if a revision of the figures included in that notice has occurred, by reference to the revised notice.

    (2)  In this paragraph and elsewhere in this Schedule—

    'submitted to' means submitted to the Inland Revenue in accordance with their requirements by or on behalf of the self-employed earner; and

    a 'tax calculation notice' means a document issued by the Inland Revenue containing information as to the income of a self-employed earner;

    a 'revision of the figures' means the revision of the figures relating to the total taxable profit of a self-employed earner following an enquiry under section 9A of the Taxes Management Act 1970 or otherwise by the Inland Revenue.

    2C   Where the child support officer accepts that it is not reasonably practicable for the self-employed earner to provide information relating to his total taxable profits from self-employment in the form submitted to, or (where paragraph 2B applies) as issued or revised by, the Inland Revenue, 'earnings' in relation to that earner shall have the meaning given by paragraph 3 of this Schedule."

There is also a new para 5A dealing with accounting periods for the purposes of the new para 2A, and also (para 5A(3)) conferring a residual power to compute earnings under para 3 where the information available "does not accurately reflect the normal weekly earnings of the self-employed earner."

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